Chapter 9: Plant and Intangible Assets Notes

Plant Assets

Plant assets are long-term prepaid expenses, representing future services.

Types of Plant Assets

Tangible Plant Assets: Possess physical substance.
- Property subject to depreciation (e.g., buildings, equipment).
- Land: Not depreciated due to unlimited life and constant utility.
Intangible Assets: Used in business operations without physical form and are noncurrent (e.g., patents, copyrights, trademarks, franchises, goodwill).
Natural Resources: Include assets like oil, minerals, and timber.

Accountable Events for Plant Assets

Acquisition: Initial purchase of the asset.
Allocation: Cost allocation to expense over the asset's life (excluding land), known as depreciation/amortization.
Sale or Disposal: When the asset is sold, retired, or otherwise disposed of.

Acquisitions of Plant Assets

The cost includes all reasonable and necessary expenditures to get the asset ready for use and in the desired location.

Included Costs

Basic asset cost.
Sales taxes.
Delivery costs.
Installation costs.

Excluded Costs

Costs due to damage during unloading are expensed immediately, not capitalized as part of the asset's cost.
Interest charges after the asset is ready for use are recorded as interest expense. However, interest during the construction of a plant asset for self-use is part of the asset's cost.

Example: Determining the Cost of a Machine

A factory orders a machine with a list price of $10,000, paying in installments that include $2,000 interest. They also pay $600 in sales tax, $1,350 for freight, and $500 for installation. The cost to be capitalized is:

List price: $10,000$
Sales tax: $600$
Freight: $1,350$
Installation: $500$
Total cost: $10,000 + 600 + 1,350 + 500 = 12,450$

The interest charges are expensed separately.

Land

Incidental costs in addition to the purchase price are included in the cost of land.

Included Costs

Real estate broker commissions.
Escrow fees.
Legal fees for title examination and insurance.
Delinquent taxes paid by the purchaser.
Costs for surveying, draining, clearing, and grading.

Special Situations

If land with an unusable building is purchased, the entire cost, including demolition, is charged to the Land account.

Land Improvements

Land improvements are depreciable assets with limited lives, recorded separately.

Examples

Driveways
Fences
Parking lots
Landscaping
Sprinkler systems

Buildings

Remodeling costs before the building is in use are capitalized. Ordinary repairs after use are expensed.

Equipment

Include sales taxes, delivery, and preparation costs. Maintenance, insurance, and property taxes are expensed.

Allocation of Lump-Sum Purchase

When multiple assets (land, buildings, equipment) are bought together, the purchase price must be allocated among them, potentially requiring an appraisal.

Example

Exercise-for-Health purchases a fitness center for $800,000. The allocation based on appraisal values is recorded via journal entry.

Capital and Revenue Expenditures

Capital Expenditures

Recorded in asset accounts.
Material expenditures benefiting multiple accounting periods.

Revenue Expenditures

Recorded in expense accounts.
Expenditures benefiting only the current period or immaterial in amount.

Depreciation Process

Cost allocation of a tangible plant asset to expense over its useful life.

Depreciation Terms

Book Value: Cost minus accumulated depreciation.
$Book Value = Cost - Accumulated Depreciation$
Accumulated Depreciation: Contra-asset account representing the portion of the asset's cost already expensed.
Causes of Depreciation: Physical deterioration and obsolescence.

Methods of Computing Depreciation

GAAP requires a rational and systematic allocation of cost.

Straight-Line Method: Equal depreciation expense each period.
Accelerated Depreciation: Higher depreciation expense in early years.

Straight-Line vs. Accelerated

Total depreciation is the same over the asset's life.

Straight-Line Depreciation: Example

Truck cost: $17,000$ , Residual value: $2,000$ , Useful life: 5 years.

Annual Depreciation = (Cost - Residual Value) / Useful Life
\frac{(17,000 - 2,000)}{5} = 3,000

Depreciation for Fractional Periods

Estimate by rounding to the nearest whole month or using the half-year convention.

Half-Year Convention

Record one-half year’s depreciation in the acquisition year.

Example

Computers cost 600,000, 3-year life, no residual value.

Full-year depreciation: ( $600,000 -$ 0) / 3 = $200,000$
Half-year depreciation: $200,000 * (1/2) =$ 100,000

Declining-Balance Method

Depreciation is higher in early years.

Double-declining-balance rate = 2 * (1 / Useful Life).

Financial Statement Disclosures

Disclose depreciation methods, useful life estimates, and residual values.

Principle of Consistency

Consistent application of accounting methods is required for depreciation expense computation. Companies can use different methods for different assets or financial statements vs. tax returns.

Revision of Estimated Useful Lives

Change periodic depreciation expense based on the revised estimate.

Revising Depreciation Rates: Example

Asset cost: 10,000, 5-year life, no residual value. After 3 years, the estimated life extends by 5 more years (total 8 years).

Impairment of Plant Assets

Write down the asset to its fair value and recognize an impairment loss if the carrying amount is unrecoverable.

Units-of-Output Depreciation Method

Based on output rather than time.

Units-of-Output: Example

Truck cost 35,000 $, salvage value$ 5,000, planned 60,000 miles.

Depreciation rate = (Cost - Salvage Value) / Total Units of Output
\frac{( $35,000 -$ 5,000)}{60,000} = $0.50 per mile$

MACRS

Modified Accelerated Cost Recovery System is used for tax returns and sometimes by small businesses in their financial statements.

Not considered GAAP-compliant for publicly traded companies.

Disposal of Plant and Equipment

Remove cost and accumulated depreciation upon disposal.

Disposal: Price Above Book Value

Machine cost $10,000$ , accumulated depreciation $8,000$ , sold for $3,000$ cash.

Disposal: Price Below Book Value

Machine cost $10,000$ , accumulated depreciation $8,000$ , sold for $500$ cash.

Trading in Used Assets for New Ones

Rancho Landscape trades an old truck for a new truck costing $25,000$ . They receive a $3,500$ trade-in allowance on the old truck, which had a book value of $2,000$ . Rancho pays the remaining $21,500$ cost of the new truck in cash.

International Financial Reporting Standards

Companies can revalue assets to fair value under international standards if fair value is reliably measurable.

Intangible Assets

Long-term assets with no physical substance used to generate income, valued at cost.

Examples

Patents, trademarks, goodwill.

Operating Expenses vs. Intangible Assets

Expenditures qualify as intangible assets if there is reasonable evidence of future benefits.

Amortization

Systematic write-off to expense of an intangible asset's cost over its useful life, similar to depreciation.

The straight-line method is typically used.

Goodwill

Excess amount paid in an acquisition over the fair value of net identifiable assets.

Positive attributes include

Favorable reputation
Positive market share
Superior management
Operating efficiency

Patents

Exclusive right granted by the government is for manufacture, use, and sale of a product.

Patents are granted for 20 years.

Patent: Example

A patent is purchased for $100,000$ , after five years of its legal life have expired. If the useful life is only eight years, amortization is based on this shorter period.

Trademarks and Brand Names

Name, symbol, or design that identifies a product.

If purchased, the cost is capitalized and amortized. Advertising is usually expensed.

Franchises

Right to conduct business in a specific area. Cost is amortized over the life of the franchise.

Copyrights

Exclusive right to protect literary or artistic materials, life of creator plus 70 years.

Research and Development (R&D) Costs

Expensed when incurred as a general rule, according to the Financial Accounting Standards Board.

Accounting for Natural Resources

Physically removed from their natural environment and converted into inventory, classified as property, plant, and equipment on the balance sheet.

Examples

Mining properties, oil and gas reserves, and tracts of timber.

Depletion of Natural Resources

Gradual depletion as the resource is removed.

Depletion: Example

Rainbow Minerals pays $48 million$ for a mine containing 5 million tons of coal with a $8 million$ residual value. Depletion is 8 per ton.

Depletion per ton = (Cost - Residual Value) / Estimated Units
\frac{( $48,000,000 -$ 8,000,000)}{5,000,000} = $8$

If 2 million tons are mined, the depletion is $2,000,000 *$ 8 = $16,000,000$

Plant Transactions and the Statement of Cash Flows

Acquisitions and disposals are investing activities. Depreciation and amortization are noncash expenses. Noncash investing activities involve notes payable or receivable.

Ethics, Fraud, & Corporate Governance

WorldCom overstated income by improperly capitalizing operating expenses, leading to the Sarbanes-Oxley Act.